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Office of Inspector General Semiannual Report to Congress (PDF)

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					   Office of Inspector General
 Semiannual Report to Congress
      April 1, 2010 – September 30, 2010
Board of Governors of the Federal Reserve System
             Message from the Inspector General 

        On behalf of the Office of Inspector General (OIG) of the Board of Governors of the
Federal Reserve System (Board), I am pleased to present our Semiannual Report to Congress
highlighting our accomplishments and ongoing work for the six-month period ending
September 30, 2010. Challenges and opportunities stemming from the financial crisis remain
our primary focus, from reviewing the supervision and regulation of failed Board-supervised
banks, to reviewing the Federal Reserve’s lending facilities to support overall market liquidity,
to participating in nationwide efforts to investigate and prosecute mortgage-related crimes.

        Of particular note during this reporting period, Congress passed and the President
signed into law the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-
Frank Act). The Dodd-Frank Act brings significant and wide-ranging reforms to the financial
sector to promote the financial stability of the United States by improving accountability and
transparency in the financial system, and to protect consumers from abusive financial services
practices. In short, the Dodd-Frank Act seeks to prevent a repeat of the recent financial crisis.

        Our office is already busy addressing our new responsibilities under the Dodd-Frank
Act. For example, the act increases the threshold for conducting material loss reviews of failed
banks to $200 million for losses that occur through December 31, 2011, and requires the
Inspector General (IG) of the cognizant financial regulatory agency to review each bank failure
with an estimated loss below the threshold to determine if unusual circumstances exist that
warrant a more in-depth review. The act requires us to report semiannually on these
determinations, and our first report on the 12 Board-supervised banks that fell below the
threshold is included as part of this semiannual report. Collectively, these 12 institutions had
total assets of about $3.8 billion and losses estimated at $626 million, or 16.6 percent of total
assets.

        The Dodd-Frank Act also creates the Bureau of Consumer Financial Protection
(Bureau) as an independent entity within the Federal Reserve System, and designates our office
as the OIG for the Bureau. The Bureau’s mission is to implement and, as applicable, enforce
federal consumer law consistently to ensure that all consumers have access to markets for
financial products and services, and that these markets are fair, transparent, and competitive.
The Secretary of the Treasury—who is currently the acting head of the Bureau—has
designated July 21, 2011, as the date that certain authorities will transfer from other agencies to
the Bureau and that the Bureau will be able to exercise additional, new authorities. We are
monitoring the activities that are already under way to create the new Bureau and coordinating
our efforts with the U.S. Department of the Treasury’s (Treasury’s) OIG. We are also
developing a strategic plan for fulfilling our new oversight responsibilities, and addressing
budget and staffing requirements going forward.

        In addition, the Dodd-Frank Act creates the Financial Stability Oversight Council
(FSOC) to monitor emerging threats to financial stability, designate for supervision those
nonbank financial firms and market utilities that could pose threats to financial stability, and
identify gaps in the financial regulatory framework. The FSOC includes representatives from
the key federal financial regulatory agencies, including the Board and the Bureau. At the
same time, the Dodd-Frank Act establishes the Council of Inspectors General on Financial
Oversight (CIGFO), which consists of the IGs for the Federal agencies represented on the
FSOC, as well as the IG for the Department of Housing and Urban Development and the
Special IG for the Troubled Asset Relief Program. Under the leadership of the Treasury IG,
the CIGFO meets at least quarterly to share information among the IGs and to discuss the
ongoing work of each IG, with a focus on concerns that may apply to the broader financial
sector and ways to improve financial oversight. In addition, the CIGFO is required to annually
issue a report that highlights the IGs’ concerns and recommendations, as well as issues that
may apply to the broader financial sector. The CIGFO recently held its first meeting and is
taking steps to fulfill this new mandate.

        We look forward to working with the Board, the Bureau’s transition team, and Congress
to accomplish the new requirements of the Dodd-Frank Act and to enhance the economy,
efficiency, and effectiveness of the Board and the Bureau in achieving their respective missions.

                                            Sincerely,




                                     Elizabeth A. Coleman
                                       Inspector General

                                        October 28, 2010
Semiannual Report to Congress
  April 1, 2010 – September 30, 2010
Table of Contents
                                                                                                                    Page

Highlights.................................................................................................................1

Introduction ..............................................................................................................3

Overview of the OIG’s Strategic Plan, 2008 – 2011 ...............................................5

Organization Chart ...................................................................................................6

Audits and Attestations ............................................................................................7

Multi-disciplinary Work ........................................................................................12

Inspections and Evaluations...................................................................................13

Information on Nonmaterial Losses to the Deposit Insurance Fund,
as Required by the Dodd-Frank Act ......................................................................29

Investigations .........................................................................................................31

Legal Services ........................................................................................................36

Communications and Coordination .......................................................................37

Appendixes

   Appendix 1—Audit, Inspection, and Evaluation Reports Issued with
              Questioned Costs during the Reporting Period ..........................43

   Appendix 2—Audit, Inspection, and Evaluation Reports Issued with
              Recommendations that Funds Be Put to Better Use
              during the Reporting Period .......................................................44

   Appendix 3—OIG Reports with Recommendations that Were Open
              during the Reporting Period ........................................................45

   Appendix 4—Audit, Inspection, and Evaluation Reports Issued
              during the Reporting Period ........................................................47

   Appendix 5—OIG Peer Reviews .......................................................................48

   Appendix 6—Cross-References to the Inspector General Act, as amended .....49

Table of Acronyms and Abbreviations ..................................................................51



Semiannual Report to Congress                                      i                                      October 2010
Highlights
The Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-
Frank Act), Public Law No. 111-203, enacted into law on July 21, 2010, creates,
among other things, the Bureau of Consumer Financial Protection (Bureau) as
an independent entity within the Federal Reserve System. The act also
designates our office as the Bureau’s Office of Inspector General (OIG). The
new Bureau’s mission is to implement and, as applicable, enforce federal
consumer law consistently to ensure that all consumers have access to markets
for financial products and services, and that these markets are fair, transparent,
and competitive. The Secretary of the Treasury—who is currently the acting
head of the Bureau—has designated July 21, 2011, as the date that designated
consumer protection functions will transfer from the Board and other agencies
to the Bureau.

Since the Dodd-Frank Act was only recently enacted, this semiannual report
focuses on our work related to the programs and operations of the Board of
Governors of the Federal Reserve System (Board). Going forward, the OIG
will be providing appropriate monitoring and oversight of the Bureau’s
operations, consistent with the Inspector General Act of 1978, as amended (IG
Act), 5 U.S.C. app. 3. The following are highlights of the OIG’s work during
this reporting period:

   We continued to direct a significant portion of our resources to reviews of
    failed state member banks. Eight state member banks failed during the last six
    months, bringing the total number of failed state member banks since
    December 2008 to 30, with the associated cumulative loss to the Deposit
    Insurance Fund (DIF) estimated to be $4.5 billion. During the reporting
    period, we issued eight reports on reviews of failed banks, and we initiated an
    assessment of our cumulative body of bank failure reviews to identify any
    cross-cutting themes and potential recommendations for improvements in the
    supervision of state member banks.

   Work also continued on our review of the status of the six lending facilities
    that the Board established, pursuant to its authority under section 13(3) of the
    Federal Reserve Act, to help stabilize financial markets and restore overall
    market liquidity. Currently, the report on the results of our review is being
    finalized, and we anticipate issuing it within the next several weeks.

   Our investigative staff had several successes during the reporting period.

     One of the subjects of a multi-agency investigation into an “advance fee”
      scheme was sentenced to eight years in federal prison and was ordered to
      pay approximately $3.8 million in restitution to victims who were falsely
      promised low-interest, multi-million dollar loans.




Semiannual Report to Congress             1                              October 2010
     In a separate case, a Board employee entered a guilty plea in connection
      with an investigation into the theft of Board cell phones and the associated
      calling charges.

     In another multi-agency case, a subject pleaded guilty to one count of
      trafficking in counterfeit goods after a federal grand jury indictment on
      charges of money laundering and trafficking in counterfeit goods that
      included the “structured” purchase of Postal Money Orders valued at
      $579,865.

     Our investigative staff also continues to participate in nationwide efforts to
      prosecute mortgage-related crimes. An investigation by OIG special
      agents assigned to the Maryland Mortgage Fraud Task Force recently
      resulted in the arrest of three subjects involved in a mortgage fraud
      scheme that netted more than $1.2 million from three federally regulated
      financial institutions.

As events in the financial regulatory environment continue to unfold, we remain
committed to appropriately balancing our statutory and risk-focused work to
promote integrity, economy, efficiency, and effectiveness in Board programs and
operations and to strengthen accountability to Congress and the public.




Semiannual Report to Congress            2                              October 2010
Introduction
With the enactment of the Dodd-Frank Act on July 21, 2010, which amended
several provisions of the IG Act, the oversight responsibilities of the Board’s OIG
were expanded to include the Bureau. However, given the timing of the act, this
semiannual report focuses on the OIG’s work related to Board programs and
operations. As the Bureau stands up and prepares for the designated transfer date
of July 21, 2011, the OIG will provide monitoring and oversight of the Bureau’s
operations, consistent with the IG Act. During this reporting period, we focused
on our mission to

    conduct and supervise independent and objective audits, investigations, and
     other reviews of the Board’s programs and operations;

    promote economy, efficiency, and effectiveness within the Board;

    help prevent and detect fraud, waste, and mismanagement in the Board’s
     programs and operations;

    review existing and proposed legislation and regulations and make
     recommendations regarding possible improvements to the Board’s programs
     and operations; and

    keep the Board and Congress fully and currently informed of problems
     relating to the administration of the Board’s programs and operations.

Congress has also mandated additional responsibilities that influence where the
OIG directs its resources, to include the following. Section 38(k) of the Federal
Deposit Insurance Act (FDI Act) requires the OIG to review failed financial
institutions supervised by the Board that result in a material loss to the DIF and to
produce a report within six months. The Dodd-Frank Act amended section 38(k)
of the FDI Act to raise the materiality threshold and to require the OIG to conduct
an in-depth review and prepare a written report regarding any nonmaterial losses
to the DIF that exhibit unusual circumstances warranting an in-depth review.

In addition, section 211(f) of the Dodd-Frank Act requires the OIG to review the
Board’s supervision of any covered financial company that is placed into
receivership and produce a report that evaluates the effectiveness of the Board’s
supervision, identifies any acts or omissions by the Board that contributed to or
could have prevented the company’s receivership status, and recommends
appropriate administrative or legislative action.

Further, section 989E of the Dodd-Frank Act established the Council of
Inspectors General on Financial Oversight (CIGFO), which comprises the
Inspectors General (IGs) of the Board, the Commodity Futures Trading
Commission, the Department of Housing and Urban Development, the U.S.
Department of the Treasury (Treasury), the Federal Deposit Insurance
Corporation (FDIC), the Federal Housing Finance Agency, the National Credit
Union Administration, the Securities and Exchange Commission, and the

Semiannual Report to Congress             3                              October 2010
Troubled Asset Relief Program (TARP). The CIGFO is required to meet at least
quarterly to share information and to discuss the ongoing work of each IG, with a
focus on concerns that may apply to the broader financial sector and ways to
improve financial oversight. Additionally, the CIGFO is required to annually
issue a report that highlights the IGs’ concerns and recommendations, as well as
issues that may apply to the broader financial sector.

In the information technology arena, the Federal Information Security
Management Act of 2002 (FISMA), Title III of Public Law No. 107-347,
provides a comprehensive framework for ensuring the effectiveness of
information security controls over resources that support federal operations and
assets. Consistent with FISMA’s requirements, we perform an annual
independent evaluation of the Board’s information security program and
practices, which includes evaluating the effectiveness of security controls and
techniques for selected information systems.

The USA PATRIOT Act of 2001, Public Law No. 107-56, grants the Board
certain federal law enforcement authorities. Our office serves as the external
oversight function for the Board’s law enforcement program and operations.

In addition, we oversee the annual financial statement audits of the Board and the
Federal Financial Institutions Examination Council (FFIEC).




Semiannual Report to Congress             4                            October 2010
Overview of the OIG’s Strategic Plan, 2008 – 2011

The following chart represents the structure of the OIG’s existing Strategic Plan;
however, we are currently updating the Strategic Plan to incorporate, among other
things, new requirements under the Dodd-Frank Act, including our
responsibilities as the OIG for the new Bureau of Consumer Financial Protection.




Semiannual Report to Congress               5                          October 2010
                     Organization Chart
                                      OFFICE OF INSPECTOR GENERAL
                                                                  (October 2010)




                                                                  Inspector General
                                                                Elizabeth A. Coleman




                             Information Systems                                                       Assistant IG for
                                   Manager                                                             Legal Services
                                 Sue Bowman                                                         Jacqueline M. Becker




                               Assistant IG for                                        Assistant IG for                 Assistant IG for
                            Audits and Attestations                              Inspections and Evaluations             Investigations
                             Andrew Patchan, Jr.                                     Anthony J. Castaldo              Harvey Witherspoon


Senior Program Manager
                                                                                                                                      Senior Investigative
for Communications & QA
      Elise M. Ennis                                                                                                                       Advisor
                                                                                                                                      Donna M. Harrison



                Project Manager               Project Manager            Project Manager            Project Manager
                 Cynthia Gray                 Peter Sheridan             Kimberly Whitten           Timothy Rogers




                                                                   OIG Staff




                                                                       OIG Staffing


                                               Auditors (including Information Technology)            42
                                               Investigators                                          11
                                               Attorneys                                               4
                                               Administrative and Hotline                              5
                                               Information Systems Analysts                            3
                                                          Total Authorized Positions                  65




                     Semiannual Report to Congress                               6                                    October 2010
Audits and Attestations
The Audits and Attestations program assesses certain aspects of the economy,
efficiency, and effectiveness of the Board’s programs and operations. For
example, the office of Audits and Attestations conducts audits of (1) the
presentation and accuracy of the Board’s financial statements and financial
performance reports; (2) the effectiveness of processes and internal controls over
the Board’s programs and operations; (3) the adequacy of controls and security
measures governing the Board’s financial and management information systems
and the safeguarding of the Board’s assets and sensitive information; and
(4) compliance with applicable laws and regulations related to the Board’s
financial, administrative, and program operations. As mandated by the IG Act,
OIG audits and attestations are performed in accordance with the Government
Auditing Standards established by the Comptroller General. The information
below summarizes OIG work completed during the reporting period and ongoing
work that will continue into the next semiannual reporting period.


COMPLETED AUDIT WORK

Security Control Review of the Lotus Notes and Lotus Domino Infrastructure

To evaluate the security controls and techniques of the information systems of the
Board, the OIG reviews controls over associated major applications on an
ongoing basis. Consistent with the requirements of FISMA, we conducted a
security control review of the Board’s Lotus Notes and Lotus Domino
infrastructure. The Lotus Notes and Lotus Domino infrastructure is a component
of the general support system supported by the Board’s Division of Information
Technology. The general support system infrastructure provides network and
general computing capabilities for the Board’s end-user community. The Lotus
Notes application provides users with access to e-mail, calendar, and other
databases that reside in a Lotus Domino server environment.

Our audit objective was to evaluate the adequacy of selected security controls for
protecting the Lotus Notes and Lotus Domino infrastructure from unauthorized
access, modification, destruction, or disclosure. To accomplish our objective, we
developed a control assessment methodology based on the security controls
identified in the National Institute of Standards and Technology Special
Publication 800-53, Recommended Security Controls for Federal Information
Systems. This document provides a baseline of security controls for organizations
to use in protecting their information systems. The controls are divided into 17
“families,” such as access control, risk assessment, and personnel security.

Overall, the audit showed that controls were generally well-designed and well-
implemented. However, we found opportunities to strengthen information
security controls in the control families that we evaluated. For those control
families where control objectives were not met, we identified the aspect of the
control that was deficient or where improvements could be made, and we

Semiannual Report to Congress               7                          October 2010
highlighted recommended action. The Director of the Division of Information
Technology generally agreed with our recommendations and identified corrective
actions that have been taken, are under way, or are planned to enhance the
specific controls highlighted in the report. We will follow up on the
implementation of the recommendations as part of our future audit activities
related to the Board’s continuing implementation of FISMA.


ONGOING WORK

Review of the Federal Reserve’s Section 13(3) Lending Facilities to Support
Overall Market Liquidity

During this reporting period, we issued to Board officials, for review and
comment, our draft report on the six lending facilities that the Federal Reserve
established to support overall market liquidity. In response to the financial crisis,
the Board initiated a number of lending facilities to restore liquidity in the
economy and preserve financial and economic stability. The six lending facilities
that we reviewed were established pursuant to the Board’s authority under section
13(3) of the Federal Reserve Act to authorize Federal Reserve Banks, in unusual
and exigent circumstances, to extend credit to individuals, partnerships, and
corporations that are unable to obtain adequate credit accommodations from other
banking institutions. Under Board authorization, the Federal Reserve Bank of
New York managed five of the lending facilities, and the Federal Reserve Bank of
Boston managed the sixth. Through their respective facilities, the Federal
Reserve Banks of New York and Boston collectively provided loans to depository
institutions, bank holding companies, commercial paper issuers, and primary
dealers.

We performed an independent review of these six lending facilities to inform the
Board, the Congress, and the public regarding the lending facilities’ function,
status, and risks. The objectives of our review were to (1) obtain information on
the various Federal Reserve lending facilities, including their overall function and
status, how they operated, the financial markets they were intended to support, the
financial utilization of the facilities, the total amount of loans extended, and the
current outstanding balances; and (2) identify risks in each facility for the Board’s
review in exercising its monetary policy function and in its general supervision
and oversight of the Federal Reserve Banks. We anticipate issuing our final
report early in the next reporting period.




Semiannual Report to Congress              8                             October 2010
Audit of the Board’s Financial Statements for the Year Ending December 31,
2010, and Audit of the Federal Financial Institutions Examination Council’s
Financial Statements for the Year Ending December 31, 2010

We contract for an independent public accounting firm to annually audit the
financial statements of the Board and the FFIEC. (The Board performs the
accounting function for the FFIEC.) The accounting firm, currently Deloitte &
Touche LLP, performs the audits to obtain reasonable assurance that the financial
statements are free of material misstatement. The OIG oversees the activities of
the contractor to ensure compliance with generally accepted government auditing
standards. The audits include examining, on a test basis, evidence supporting the
amounts and disclosures in the financial statements. The audits also include an
assessment of the accounting principles used and significant estimates made by
management, as well as an evaluation of the overall financial statement
presentation.

To determine the auditing procedures necessary to express an opinion on the
financial statements, the auditors will review the Board’s and the FFIEC's internal
controls over financial reporting. The auditors will also express an opinion on the
effectiveness of the Board’s internal controls over financial reporting based on the
Government Auditing Standards and the Public Company Accounting Oversight
Board standards. As part of obtaining reasonable assurance that the financial
statements are free of material misstatement, the auditors also will perform tests
of the Board’s and the FFIEC’s compliance with certain provisions of laws and
regulations, since noncompliance with these provisions could have a direct and
material effect on the determination of the financial statement amounts. The audit
reports will be issued in the next reporting period.


Survey of Supervision and Systemic Risk

We began an audit survey of the Board’s approach and activities in the areas of
supervision and systemic risk in response to the recently enacted Dodd-Frank Act.
The Dodd-Frank Act provides for a number of new requirements and
responsibilities for the Federal Reserve System, including the Board’s
membership on the new Financial Stability Oversight Council and the supervision
of systemically important financial companies. The objective of this survey is to
obtain information on the Board’s Division of Banking Supervision and
Regulation’s activities regarding (1) the supervision of bank holding companies
and systemically important financial institutions, and (2) the monitoring of and
response to emerging systemic risks in the U.S. financial system in support of the
Board’s role as a member of the Financial Stability Oversight Council. Based on
this survey, we plan to identify specific areas for future audits, as appropriate.




Semiannual Report to Congress             9                             October 2010
Audit of the Board’s Information Security Program

We began an audit of the Board's information security program and practices.
This audit was initiated pursuant to FISMA, which requires that each agency IG
conduct an annual independent evaluation of the agency's information security
program and practices. Our specific audit objectives, based on FISMA's
requirements, are to evaluate the effectiveness of security controls and techniques
for selected information systems and to evaluate compliance by the Board with
FISMA and related information security policies, procedures, standards, and
guidelines. In accordance with revised reporting requirements, our FISMA
review includes an analysis of the Board’s security-related processes in the
following areas: certification and accreditation, continuous monitoring, plans of
action and milestones, account and identity management, remote access, security
configuration management, security training, contractor oversight, contingency
planning, and incident response and reporting. We expect to complete this project
and issue our final report in the next reporting period.


Security Control Review of the Internet Electronic Submission System

During this period, we issued to management, for review and comment, a draft
report on our security control review of the Internet Electronic Submission
(IESub) system developed and maintained by the Federal Reserve Bank of New
York’s Research and Statistics Group. IESub is a major third-party application on
the Board’s FISMA application inventory under the Division of Monetary Affairs.
It provides an interface for the respondents of regulatory and statistical reports to
submit their data via the internet. Our objectives are to (1) evaluate the
effectiveness of selected security controls and techniques for protecting IESub
from unauthorized access, modification, or destruction and (2) ensure compliance
with the Board’s information security program. We expect to complete this
project and issue our final report in the next reporting period.


Security Control Review of the Board’s Public Website

We began a security control review of the Board’s public website (PubWeb).
PubWeb is listed as a major application on the Board’s FISMA inventory for the
Office of Board Members. As part of the Board’s Publications Program, PubWeb
provides the public with timely and accurate information about the mission and
work of the Board. This information includes materials required by the Federal
Reserve Act and other federal legislation. PubWeb also provides information
related to the functions of the Federal Reserve System, including financial
information such as monetary policy reports, testimony and speeches, economic
research and data, reporting forms, and consumer information.




Semiannual Report to Congress             10                             October 2010
Our objectives are to evaluate the effectiveness of selected security controls and
techniques for protecting PubWeb from unauthorized access, modification, or
destruction; and to ensure compliance with the Board’s information security
program. We expect to complete this project and issue our final report in the next
reporting period.


Security Control Review of the Visitor Registration System

We began a security control review of the Board’s Visitor Registration System.
The Visitor Registration System is listed as a major application on the Board’s
FISMA inventory. The Visitor Registration System allows Board employees to
register Board visitors; provides administrative users the ability to manage
registered visitors, run reports, and manage access roles; and provides law
enforcement officer users the ability to sign visitors in and out, print badges, and
manage registered visitors.

Our objectives are to evaluate the effectiveness of selected security controls and
techniques for protecting the Visitor Registration System from unauthorized
access, modification, or destruction; and to ensure compliance with the Board’s
information security program. We expect to complete this project and issue our
final report in the next reporting period.


Security Control Review of the National Remote Access Services

We began a security control review of the Federal Reserve System’s National
Remote Access Services (NRAS). The Board and the 12 Federal Reserve Banks
use NRAS for remotely accessing Board and Federal Reserve Bank information
systems. Our objectives are to evaluate the effectiveness of selected security
controls and techniques to ensure the Board maintains a remote access program
that complies with FISMA requirements. We expect to complete this project and
issue our final report in the next reporting period.


Security Control Review of the FISMA Assets Maintained by the
Federal Reserve Bank of Richmond

Pursuant to the requirements of FISMA, we began a security control review of
two Lotus Notes applications listed on the Board’s FISMA inventory and
maintained by the Federal Reserve Bank of Richmond. The two database
applications are used by the Federal Reserve Bank of Richmond to support bank
examinations. Our objectives are to evaluate the effectiveness of selected security
controls and techniques for protecting the two Lotus Notes applications from
unauthorized access, modification, or destruction; and to ensure compliance with



Semiannual Report to Congress             11                              October 2010
the Board’s information security program. We expect to complete this review and
issue our final report in the next reporting period.


Audit of the Board’s Transportation Subsidy Program

We issued to management, for review and comment, a draft report on our audit of
the Board’s transportation subsidy program. The Board supports federal
government initiatives to conserve energy, reduce traffic congestion, and improve
air quality in operating a $1.2 million subsidy program for approximately 1,100
Board employees who commute to work using public transportation. We initiated
this audit in response to reports of abuse and fraud in the federal transit benefits
program at other government agencies. Our objective is to determine the extent to
which the Board’s transportation subsidy program is properly controlled and
administered. We expect to complete this project and issue our final report in the
next reporting period.


Multi-disciplinary Work
Inquiry into Allegations of Undue Influence

During this reporting period, our office began an inquiry into allegations of
inappropriate political influence on Federal Reserve System officials, resulting in
hidden transfers of resources to facilitate crimes during the Watergate scandal in
the 1970s and to Iraq for weapon purchases during the 1980s. These allegations
were raised at a February 2010 House Committee on Financial Services hearing.
Our inquiry was initiated in response to a request from the Chairman of the House
Committee on Financial Services, which the Board referred to our office.




Semiannual Report to Congress             12                            October 2010
Inspections and Evaluations
The Inspections and Evaluations program encompasses OIG inspections, program
evaluations, enterprise risk management activities, process design and life-cycle
evaluations, and legislatively-mandated reviews of failed financial institutions that
the Board supervises. Inspections are generally narrowly focused on a particular
issue or topic and provide time-critical analysis that cuts across functions and
organizations. In contrast, evaluations are generally focused on a specific program
or function and make extensive use of statistical and quantitative analytical
techniques. Evaluations can also encompass other preventive activities, such as
reviews of system development life-cycle projects and participation on task forces
and workgroups. OIG inspections and evaluations are performed according to the
Quality Standards for Inspections issued by the Council of the Inspectors General
on Integrity and Efficiency (CIGIE).


COMPLETED INSPECTION AND EVALUATION WORK

Material Loss Reviews

                            Section 38(k) of the FDI Act requires that the IG of the
                            appropriate federal banking agency complete a review
                            of the agency’s supervision of a failed institution and
                            issue a report within six months of notification from
                            the FDIC IG when the projected loss to the DIF is
                            material. Under section 38(k) of the FDI Act, as
                            amended, a material loss to the DIF is defined as an
                            estimated loss in excess of $200 million. Pursuant to
the Dodd-Frank Act, this threshold applies if the loss occurs between January 1,
2010, and December 31, 2011.

The material loss review provisions of section 38(k) require that the IG

   review the institution’s supervision, including the agency’s implementation of
    prompt corrective action (PCA);

   ascertain why the institution’s problems resulted in a material loss to the DIF; and

   make recommendations for preventing any such loss in the future.

The Dodd-Frank Act also contains specific requirements for bank failures that
result in losses below the materiality threshold. In these situations, the IG must
review the failure to determine, among other things, whether the loss exhibits
unusual circumstances that warrant an in-depth review. In such cases, the IG
must prepare a report in a manner that is consistent with the requirements of a
material loss review. Pursuant to the Dodd-Frank Act, the IG must semiannually
report the dates when each such review and report will be completed. However, if
it is determined that a loss did not involve unusual circumstances, the IG is

Semiannual Report to Congress                13                         October 2010
required to provide an explanation of its determination in the above mentioned
semiannual report. The OIG has included its report on nonmaterial loss bank
failures in this Semiannual Report to Congress (see pages 29 and 30).

During this reporting period, we issued reports on seven failed state member
banks where losses to the DIF exceeded the materiality threshold. We also issued
one report on a failed state member bank with a loss that did not meet the
materiality threshold but that presented unusual circumstances.1 These banks had
total assets of approximately $8.4 billion and total losses estimated at $2 billion,
or approximately 24 percent of total assets.

Failed Bank Reviews Completed during the Reporting Period
                                                 Federal                         Projected                        FDIC IG
                                                 Reserve         Asset size        Loss           Closure       Notification
  State Member Bank            Location           Bank         (in millions)   (in millions)        Date           Datea

 Irwin Union Bank           Columbus, IN         Chicago           $2,700.0       $552.4        09/18/2009       10/29/2009
   and Trust

 Warren Bank                  Warren, MI         Chicago           $ 530.9        $276.3        10/02/2009       10/29/2009

 San Joaquin Bank            Bakersfield,          San             $ 771.8        $ 90.4        10/16/2009       11/12/2009
                                CA              Francisco

 Bank of Elmwood              Racine, WI         Chicago           $ 339.1         $ 90.6       10/23/2009       11/12/2009

 Orion Bank                   Naples, FL         Atlanta           $2,700.0       $593.8        11/13/2009       12/14/2009

 SolutionsBank                 Overland        Kansas City         $ 510.1        $119.0        12/11/2009       01/04/2010
                               Park, KS

 Barnes Banking             Kaysville, UT          San             $ 745.5        $266.3        01/15/2010       03/03/2010
   Company                                      Francisco

 Marco Community             Marco Island,       Atlanta           $ 126.9        $ 36.9        02/19/2010          N/A
  Bankb                          FL
  a. Date that our office received notification from the FDIC IG that the projected loss to the DIF would be material.
  b. Marco Community Bank did not meet the materiality threshold; however, we determined that the bank’s failure
presented unusual circumstances warranting an in-depth review.




       1. A total of 30 state member banks failed from December 2008 through September 2010. Of those, 17 material loss
reviews have been completed by the OIG, 1 in-depth (unusual circumstances) failed bank review has been completed, 1
material loss review is ongoing, 1 in-depth (unusual circumstances) failed bank review is in progress, and 10 failed state
member banks did not meet the materiality or unusual circumstances threshold established in the Dodd-Frank Act. The
total estimated loss to the DIF for the 30 banks is approximately $4.5 billion.


Semiannual Report to Congress                                 14                                            October 2010
Material Loss Review of Irwin Union Bank and Trust

Irwin Union Bank and Trust (IUBT) was supervised by the Federal Reserve Bank
of Chicago (FRB Chicago), under delegated authority from the Board, and by the
Indiana Department of Financial Institutions (State). The State closed IUBT in
September 2009, and the FDIC was named receiver. On October 29, 2009, the
FDIC IG notified our office that IUBT’s failure would result in an estimated loss
to the DIF of $552.4 million, or about 20.5 percent of the bank’s $2.7 billion in
total assets.

IUBT failed because of the convergence of several factors. The Board of
Directors and management pursued an aggressive growth strategy between 2000
and 2005 that relied upon high-risk business models. Management also depended
on volatile non-core funding sources to support the bank’s growth strategy, which
emphasized high-risk, high-yielding assets, such as 125 percent combined loan-
to-value ratio loans. Meanwhile, management maintained few sources of liquidity
support, which further increased IUBT’s risk profile. During the 2000 to 2005
growth period, the Board of Directors and management failed to ensure that the
bank’s key corporate control functions and risk management practices kept pace
with the bank’s expansion, increasingly complex operations, and escalating risk
profile. The Board of Directors’ and management’s aggressive growth strategy
resulted in IUBT’s total assets almost tripling between 2000 and 2005. However,
for five consecutive years (2004 through 2008), the bank’s net income decreased.

In 2007, reduced secondary market demand for mortgages hampered, and
eventually eliminated, an IUBT subsidiary’s ability to sell its loans. As a result,
the subsidiary was forced to hold the loans that it had originated to sell (including
125 percent combined loan-to-value ratio loans) in a declining real estate
environment, which exposed IUBT to significant asset quality deterioration. In
addition, IUBT’s exposure to real estate market declines was compounded by a
significant concentration in commercial real estate (CRE) loans. As the value of
IUBT’s assets continued to deteriorate, its Board of Directors and management
adopted a strategy of selling more profitable business lines and branch offices to
preserve the bank’s capital. However, IUBT’s remaining assets continued to
deteriorate and deplete capital, which raised concerns about the bank’s viability
and eventually resulted in IUBT losing access to key funding sources. On
September 18, 2009, the State closed IUBT because of the imminent danger of a
liquidity shortfall and appointed the FDIC as receiver.

Our analysis of FRB Chicago’s supervision of IUBT indicated that examiners
identified key weaknesses in 2002 and 2003 regarding corporate governance, risk
management systems, and internal controls, but missed multiple subsequent
opportunities to take more forceful supervisory action. The fundamental risk
management weaknesses, corporate governance issues, and key compliance
deficiencies raised by FRB Chicago during examinations in 2002 and 2003 were
early warning signs regarding IUBT’s Board of Directors’ and management’s


Semiannual Report to Congress             15                              October 2010
capability to effectively manage a geographically dispersed, large, and complex
banking organization. Based on the 2002 and 2003 examination findings, FRB
Chicago issued two informal enforcement actions. In 2003 and 2004, IUBT was
unable to fully resolve the issues noted in the informal enforcement actions, and
unresolved issues noted during the continuous supervision process began to
accumulate. We believe that FRB Chicago had multiple opportunities between
2002 and 2009 to take additional and stronger supervisory actions.

For example, we believe that the fundamental corporate governance issues and
comprehensive liquidity risk management weaknesses noted during the
January 2002 examination provided an early warning sign that management was
not effectively managing the risks associated with adding a new bank subsidiary
engaged in high loan-to-value lending. In our opinion, the examination findings
warranted a stronger supervisory action, including an additional downgrade of the
management CAMELS component rating to reflect that management was less
than satisfactory.2 We also believe that FRB Chicago should have considered
requesting that management refrain from additional growth or corporate
restructurings affecting IUBT until the bank fully addressed the fundamental
flaws noted during this examination. We believe that strong supervisory action
would have alerted management to the urgent need to address these weaknesses
before pursuing further changes or additional growth in the lines of business.

A 2005 full scope examination cited that management’s failure to enhance its
market risk management capabilities contributed to a decrease in the bank’s
annual earnings and, in our opinion, warranted a stronger supervisory response.
During the 2005 examination, FRB Chicago also noted new and recurring
violations of laws and regulations in the bank’s mortgage lending business lines,
which we believe warranted a stronger enforcement action. In addition, a 2006
full scope examination once again revealed IUBT’s difficulties in resolving items
contained in informal enforcement actions and raised by the continuous
supervision process. We believe that IUBT’s inability to fully resolve, in a
complete and timely manner, prior informal supervisory actions and issues noted
during the continuous supervision process warranted an earlier formal
enforcement action.

In late 2007, when economic conditions caused a liquidity disruption that reduced
the bank’s access to the funding necessary to operate its home equity lending
business, FRB Chicago reiterated the risk associated with IUBT’s dependence on
uninterrupted liquidity in the secondary markets as a significant issue. Examiners
raised the same concern almost five years earlier in a 2003 examination report,
but did not hold the Board of Directors and management accountable for
addressing that risk in the intervening years. We believe that an earlier and
stronger supervisory action, such as a liquidity component ratings downgrade or a


     2. The CAMELS acronym represents six components: Capital adequacy, Asset quality, Management practices,
Earnings performance, Liquidity position, and Sensitivity to market risk. Each component and overall composite score is
assigned a rating of 1 through 5, with 1 having the least regulatory concern.


Semiannual Report to Congress                               16                                          October 2010
formal enforcement action related to liquidity risk management, might have
addressed this fundamental liquidity planning weakness.

IUBT’s failure offered valuable lessons learned. Specifically, IUBT’s failure
illustrated the importance of supervisors

         confirming effective Board of Directors and management oversight
          before a bank makes key strategic and operational changes, such as
          adding new, high-risk business lines;

         ensuring that a bank’s risk management practices and internal control
          processes keep pace with the institution’s growth, increasingly complex
          operations, and heightened risk profile;

         focusing on the key risks within each business line and ensuring that the
          Board of Directors and management comprehend, manage, and mitigate
          those risks;

         assigning CAMELS composite and component ratings consistent with
          the significance of comments raised in the narrative sections of
          examination reports to ensure that management understands the urgency
          of implementing the required corrective action measures; and

         assuring that examination reports are forward looking and anticipate
          potential risk issues that management should address, in addition to
          raising concerns and observations based on events that have already
          occurred.

The Director of the Board’s Division of Banking Supervision and Regulation
concurred with our conclusions and lessons learned.


Material Loss Review of Warren Bank

Warren Bank was supervised by FRB Chicago, under delegated authority from
the Board, and by the Michigan Office of Financial and Insurance Regulation
(State). The State closed Warren Bank on October 2, 2009, and the FDIC was
named receiver. On October 29, 2009, the FDIC IG notified our office that
Warren Bank’s failure would result in an estimated loss to the DIF of $276.3
million, or 52 percent of the bank’s $530.9 million in total assets.

Warren Bank failed because its Board of Directors and management did not
adequately manage loan portfolio risks as regional economic conditions began a
protracted decline. Management placed a high reliance on (1) the bank’s
familiarity with borrowers and (2) the collateral pledged to secure loans. Warren
Bank’s Board of Directors and management were overly optimistic about the


Semiannual Report to Congress             17                            October 2010
bank’s ability to withstand the economic downturn and did not adequately
mitigate the risks associated with a loan portfolio that was highly concentrated in
CRE. In some instances, management renewed and extended loans and advanced
additional funds to existing customers, apparently in the hope that market
conditions would improve. However, management did not properly analyze the
value of the underlying collateral and the borrowers’ creditworthiness. The
bank’s asset quality deteriorated as underlying collateral values declined and loan
defaults increased. The resulting losses eliminated earnings and depleted capital,
which ultimately led to Warren Bank’s failure.

With respect to supervision, our analysis revealed that examiners repeatedly
criticized the bank’s loan grading practices and allowance for loan and lease
losses (ALLL) methodology. Despite recurring supervisory comments and
findings, improvements made by bank management were insufficient to ensure
that the bank’s credit risk management practices were commensurate with its risk
profile. Examiners also cited recurring concerns regarding Warren Bank’s capital
position. In 2003, examiners suggested that management maintain capital well
above the PCA minimums due to the bank’s high risk profile. Management was
encouraged to set capital levels above its industry peer group. Similar concerns
were expressed in subsequent examination reports; however, Warren Bank’s year-
end risk weighted capital levels never exceeded its peers.

Examiners did not issue an enforcement action compelling the bank to rectify
recurring regulatory concerns regarding loan grading, the ALLL, and capital
levels until September 2008. In our opinion, recurrent examination comments
and findings warranted an enforcement action as early as 2006. In addition, we
believe that an earlier supervisory action requiring the bank to maintain a higher
capital threshold commensurate with its high risk profile could have reduced the
cost of the failure to the DIF.

Warren Bank’s failure offered a lesson learned that can be applied when
supervising banks with similar characteristics and circumstances. Specifically,
Warren Bank’s failure illustrated the importance of an early and forceful response
to recurring supervisory concerns, particularly when examiners determine that
capital levels are not commensurate with an institution’s overall risk profile.

The Director of the Board’s Division of Banking Supervision and Regulation
agreed with our conclusion and concurred with the lesson learned.


Material Loss Review of San Joaquin Bank

San Joaquin Bank (San Joaquin) was supervised by the Federal Reserve Bank of
San Francisco (FRB San Francisco), under delegated authority from the Board,
and by the California Department of Financial Institutions (State). The State
closed San Joaquin on October 16, 2009, and the FDIC was named receiver. On


Semiannual Report to Congress             18                            October 2010
November 12, 2009, the FDIC IG notified our office that San Joaquin’s failure
would result in an estimated loss to the DIF of $90.4 million, or 11.7 percent of
the bank’s $771.8 million in total assets.

San Joaquin failed because its Board of Directors and management did not
effectively control the risks associated with the bank’s rapid loan growth that led
to a high concentration in CRE loans and, in particular, construction, land, and
land development (CLD) loans tied to the Bakersfield, California, real estate
market. The loan growth and high concentrations occurred when the Bakersfield
real estate market was experiencing significant price appreciation. A decline in
the local real estate market, coupled with the bank’s failure to effectively manage
the increased credit risk associated with San Joaquin’s highly concentrated loan
portfolio, resulted in deteriorating asset quality and significant losses. Mounting
losses impaired earnings, eroded capital, and strained the bank’s liquidity. Efforts
to meet a regulatory deadline requiring San Joaquin to be acquired by or merge
with another financial institution were unsuccessful, and the State closed the bank
and appointed the FDIC as receiver.

With respect to the bank’s supervision, we believe that an April 2007 examination
performed by FRB San Francisco provided an opportunity for stronger
supervisory action. Examiners noted that San Joaquin’s CRE loan concentration
ranked among the highest for state member banks supervised by FRB San
Francisco. Examiners also cited management’s plan for additional loan growth,
despite signs of a slowing real estate market. In our opinion, these circumstances
offered an early opportunity for FRB San Francisco to encourage management to
mitigate the risk of asset quality deterioration from further market declines.

Further, we believe that the significance of the issues raised during a 2008 State
examination warranted a timely enforcement action compelling management to
mitigate credit risk management weaknesses and the risks associated with the
declining real estate market. The State examination report issued in July 2008
noted that San Joaquin’s financial condition had become less than satisfactory.
Examiners noted that actual asset growth for 2007 was 16 percent, or double
management’s projection. In addition, the bank’s level of construction,
residential, and lot development loans had increased notably, yet the sharp decline
in the Bakersfield real estate market had not been analyzed by management.

According to examiners, despite declining collateral values, San Joaquin
continued to grant credit extensions without obtaining updated appraisals or
reevaluating borrowers’ creditworthiness. Examiners also questioned whether
earnings would remain positive and continue to augment capital. An informal
enforcement action in the form of a Memorandum of Understanding developed
jointly with the State was issued in December 2008, approximately five months
after the State’s examination report was issued. While we believe that a stronger
supervisory action in 2007 and a more timely enforcement action in 2008 were



Semiannual Report to Congress             19                             October 2010
warranted, it is not possible to determine the degree to which any such actions
would have affected the bank’s subsequent decline or the failure’s cost to the DIF.

We believe that San Joaquin’s failure pointed to a valuable lesson learned that can
be applied when supervising community banks with similar characteristics. In our
opinion, San Joaquin’s failure illustrated that banks with exceptionally high CRE
and CLD loan concentrations require a swift and forceful supervisory response
when signs of market deterioration first become evident.

The Director of the Board’s Division of Banking Supervision and Regulation
concurred with our conclusion and lesson learned.


Material Loss Review of Bank of Elmwood

The Bank of Elmwood (Elmwood) was supervised by FRB Chicago, under
delegated authority from the Board, and by the State of Wisconsin Department of
Financial Institutions Division of Banking (State). The State closed Elmwood on
October 23, 2009, and the FDIC was named receiver. On November 12, 2009,
the FDIC IG notified our office that Elmwood’s failure would result in an
estimated loss to the DIF of $90.6 million, or about 26.7 percent of the bank’s
approximately $339.1 million in total assets.

Elmwood failed because its Board of Directors and management pursued a risky
loan growth strategy that featured new loan products and out-of-market lending
without developing adequate credit risk management controls. The growth
strategy, coupled with insufficient credit risk management controls, resulted in
poorly underwritten loans. Bank management’s inability to adequately address
loan portfolio weaknesses led to asset quality deterioration and significant losses.
Mounting losses eliminated earnings, depleted capital, and strained liquidity,
which ultimately led to the State closing Elmwood.

Our analysis of FRB Chicago’s supervision of Elmwood revealed that FRB
Chicago had opportunities for earlier and more forceful supervisory actions.
Elmwood’s loan strategy was first discussed in a 2004 State examination report
that also noted that the bank’s earnings performance “continued to be deficient”
and capital ratios remained below peer bank averages. State examiners noted that
Elmwood should control further loan growth until the bank demonstrated that it
could produce “sufficient retention of earnings to provide the bank with adequate
internal capital generation.” In its 2005 examination report, FRB Chicago
observed that the bank increased its loan portfolio by about 30 percent over the
previous two years by strategically expanding into new geographical markets and
purchasing CRE loan participations to enhance income. However, examiners
once again cited weak earnings and capital levels that remained below peer
averages.



Semiannual Report to Congress             20                             October 2010
We also believe that credit risk management weaknesses noted by examiners in
2006 and 2007 provided early warning signs regarding (1) the potential for asset
quality deterioration in Elmwood’s growing loan portfolio, and (2) management’s
ability to control the bank’s increasing credit risk profile. The examination
reports issued during this period highlighted credit administration deficiencies,
such as inadequate monitoring of out-of-market CRE participation loans,
incomplete financial data on borrowers and projects, and weak loan underwriting
standards. Examiners warned that credit administration deficiencies could make
it difficult for management to detect and promptly correct credit problems.
Additionally, the 2007 examination report noted a significant increase in
classified assets and a corresponding rise in past due and non-accrual loans, yet
the bank received a “fair” rating for its asset quality. In our opinion, the
weaknesses cited by examiners, coupled with continued marginal earnings and
capital levels below peer averages, warranted an appropriate supervisory response
in 2007 compelling bank management to immediately correct the identified
deficiencies.

While we believe that FRB Chicago had opportunities for earlier and more
forceful supervisory actions, it was not possible for us to predict the effectiveness
or impact of any corrective measures that might have been taken by the bank.
Therefore, we could not evaluate the degree to which an earlier or alternative
supervisory response would have affected Elmwood’s financial deterioration or
the ultimate cost to the DIF.

With respect to lessons learned, Elmwood’s failure illustrated the risks posed
when a bank with modest earnings and capital levels below peer averages
implements a risky loan growth strategy that features new product lines or out-of-
market lending. In these situations, examiners should ensure that management
has implemented a robust credit risk management infrastructure and is effectively
addressing shortcomings in the bank’s earnings and capital. Elmwood’s failure
also demonstrated that banks exhibiting significant growth require heightened
supervisory attention and should be subject to an immediate and forceful
supervisory response when signs of credit risk management deficiencies first
appear.

The Director of the Board’s Division of Banking Supervision and Regulation
agreed with our conclusion and lessons learned.


Material Loss Review of Orion Bank

Orion Bank (Orion) was supervised by the Federal Reserve Bank of Atlanta (FRB
Atlanta), under delegated authority from the Board, and by the Florida Office of
Financial Regulation (State). The State closed Orion on November 13, 2009, and




Semiannual Report to Congress             21                              October 2010
named the FDIC as receiver.3 On December 14, 2009, the FDIC IG advised our
office that the bank’s failure would result in an estimated loss to the DIF of
$593.8 million, or 22 percent of the bank’s $2.7 billion in total assets.

Orion failed because its Board of Directors and management did not control the
risks associated with rapid growth and an extremely high concentration in CRE
and, in particular, acquisition, development, and construction (ADC) loans.
Under the direction of the Chief Executive Officer (CEO), who had a dominant
role in the bank and held a controlling interest in the parent bank holding
company, Orion aggressively expanded its CRE and ADC loan portfolios in the
south Florida market from 2004 through 2006. A subsequent rapid decline in the
Florida real estate market led to deteriorating asset quality and significant losses,
particularly in the ADC portfolio. Bank management failed to acknowledge the
extent of the real estate market downturn and was slow in recognizing and
mitigating credit risk exposure. Mounting loan losses eliminated the bank’s
earnings, depleted capital, and ultimately led the State to close Orion.

Our analysis of FRB Atlanta’s supervision of Orion revealed that a State
examination report issued in March 2007 identified a notable change in the bank’s
risk profile resulting from a deteriorating real estate market and newly identified
weaknesses in credit risk management and Board of Directors oversight. We
believe the findings included in the State examination report should have signaled
to FRB Atlanta that additional, timely supervisory attention was warranted earlier
in 2007, instead of waiting until December 2007 to begin on-site examination
work.

The State’s March 2007 examination report revealed that the real estate market in
Orion’s service areas had deteriorated; however, the bank’s CRE and ADC loan
concentrations continued to increase. In addition, examiners noted that a
$533 million, or 70 percent, increase in CRE loans registered during the 12-month
period ending March 31, 2006, and a $406 million, or 84 percent, increase in
ADC loans registered during the same period exposed the bank to “greater credit
risk.” In contrast to the generally favorable assessment cited in a March 2006
FRB Atlanta examination report, State examiners described Orion’s loan review
program as ineffective and noted that the bank’s internal loan grading did not
identify certain problem loans. Examiners warned that “the untimely
identification of loan problems could expose the bank to additional credit losses.”
The State examination report also raised concerns that “appraisals made at the
height of the real estate market in 2004 and 2005 may not represent the realistic


      3. On November 9, 2009, the Federal Reserve Board issued an enforcement action that included a provision ordering
the removal of Orion’s Chief Executive Officer, who also served as the bank President and the Chairman of the Board of
Directors. The enforcement action stated that, in the July 2009 timeframe, the bank’s Chief Executive Officer made false
statements to the Federal Reserve and, among other things, permitted the bank to make loans that (1) exceeded and,
therefore, violated the Florida legal lending limit statute; (2) had inadequate analysis of the borrower’s creditworthiness or
capacity for repayment; and (3) were structured in a manner to make it appear that Orion was reducing its level of
classified assets. The enforcement action also indicated that the Chief Executive Officer had knowledge that these loans
were used to acquire Orion’s common and preferred stock and to purchase low quality assets from the bank. We provided
our report to the OIG’s Investigations section for further review and analysis.


Semiannual Report to Congress                                  22                                            October 2010
fair value of the collateral today,” and that Orion’s ALLL methodology should be
reconsidered in light of the residential real estate market slowdown and the bank’s
concentration in CRE loans. In addition, contrary to the positive opinion
expressed in FRB Atlanta’s 2006 examination report, State examiners commented
that Orion’s Board of Directors seemed to offer little direction or supervision and
that the CEO appeared to view the Board of Directors as a hindrance more than
anything else.

While we believe that the circumstances presented in the March 2007 State
examination report provided an opportunity for an earlier supervisory response in
2007, given the rapid decline in the real estate markets served by Orion, it was not
possible to determine whether earlier supervisory attention would have affected
Orion’s subsequent decline or the failure’s cost to the DIF.

We believe that Orion’s failure offered a valuable lesson learned that could be
applied when supervising banks with similar characteristics and circumstances.
In our opinion, Orion’s failure illustrated that financial institutions with a
dominant CEO, a weak Board of Directors, and extremely high concentrations in
risky assets such as CRE and ADC loans require (1) heightened supervisory
attention even when financial performance is strong, and (2) an immediate and
forceful supervisory response when signs of market deterioration or weaknesses
in credit risk management first become apparent.

The Director of the Board’s Division of Banking Supervision and Regulation
agreed with our conclusion and lesson learned.


Material Loss Review of SolutionsBank

SolutionsBank (Solutions) was supervised by the Federal Reserve Bank of Kansas
City (FRB Kansas City), under delegated authority from the Board, and by the
Office of the State Bank Commissioner of Kansas (State). The State closed
Solutions in December 2009, and the FDIC was named receiver. On January 4,
2010, the FDIC IG notified our office that Solutions’ failure would result in an
estimated loss to the DIF of $119.0 million, or 23.3 percent of the bank’s $510.1
million in total assets.

Solutions failed because its Board of Directors and management did not control
the risks associated with an aggressive growth strategy, funded by non-core
deposit sources, that expanded the scope of the bank’s traditional activities. This
strategy resulted in the bank developing significant CRE and CLD lending
concentrations that made the bank particularly vulnerable to real estate market
declines. As real estate markets served by the bank weakened, asset quality
deterioration strained earnings and depleted capital.




Semiannual Report to Congress             23                             October 2010
Our analysis of FRB Kansas City’s supervision of Solutions revealed that
examiners had opportunities in early 2008 for an earlier and more forceful
supervisory action given the bank’s aggressive growth strategy. In a January
2008 examination report, FRB Kansas City noted softening in the nationwide real
estate market and that the bank’s loan portfolio included a large concentration of
CRE and CLD loans. Examiners also observed that the bank’s already below peer
capital levels had declined and that the bank increased its reliance on non-core
funding sources. In our opinion, these findings presented an opportunity to
question the advisability of management continuing its aggressive growth
strategy, but FRB Kansas City only required the bank to develop a more robust
capital plan and enhance CRE risk management processes. The case for a
stronger supervisory response in the early 2008 timeframe is supported by a
January 2009 examination report, which concluded that management’s decision to
execute an aggressive growth strategy without the support of adequate capital
resulted in the bank’s unsatisfactory financial condition.

While we believe that FRB Kansas City had an opportunity for an earlier and
more forceful supervisory action, it was not possible for us to predict the
effectiveness or impact of any corrective measures. Therefore, we could not
evaluate the degree to which an earlier or more forceful supervisory response
might have affected Solutions’ financial deterioration or the failure’s ultimate cost
to the DIF.

We believe that Solutions’ failure offered lessons learned that can be applied to
supervising banks with similar characteristics and circumstances. First, a
community bank with large CRE and CLD loans relative to its total assets is
particularly vulnerable to real estate market declines. Second, the failure
underscored the risk of pursuing a new business strategy that features growth in
high-risk lending outside of an institution’s traditional market area. Finally, we
believe the failure demonstrated that examiners should assess capital needs based
on an institution’s strategy and growth targets in addition to the quantitative
regulatory capital levels established by PCA.

The Director of the Board’s Division of Banking Supervision and Regulation
concurred with our conclusion and lessons learned.


Material Loss Review of Barnes Banking Company

Barnes Banking Company (Barnes) was supervised by FRB San Francisco under
delegated authority from the Board, and by the Utah Department of Financial
Institutions (State). The State closed Barnes in January 2010, and the FDIC was
appointed receiver. On March 3, 2010, the FDIC IG notified our office that
Barnes’ failure would result in an estimated loss to the DIF of $266.3 million, or
35.7 percent of the bank’s $745.5 million in total assets.



Semiannual Report to Congress             24                             October 2010
Barnes failed because its Board of Directors and management did not effectively
control the risks associated with the bank’s aggressive growth strategy that led to
a CRE loan concentration, particularly in residential CLD loans. The bank
continued to originate CLD loans in 2007 and 2008, despite apparent weaknesses
in Utah’s real estate market and economy. The Board of Directors’ and
management’s failure to effectively manage the resulting credit risk, in
conjunction with declining market conditions, led to rapid asset quality
deterioration. The resulting loan losses depleted earnings and eroded capital,
which ultimately led the State to close Barnes.

With respect to supervision, we believe that circumstances noted during a 2007
full scope examination—including repeated regulatory criticisms, declining
market trends, and continuing growth of Barnes’ CLD loan portfolio—provided
FRB San Francisco an opportunity to pursue earlier, more forceful supervisory
action. The examination cited several deficiencies regarding credit risk
management, CRE concentrations monitoring, ALLL methodology, and other
critically important control processes. Additionally, examiners expressed concern
over (1) Barnes’ aggressive growth in CRE lending despite evidence of
pronounced economic weaknesses within that market segment, and (2) “continued
inaction” by the bank to resolve prior recommendations. We believe that other
supervisory actions were warranted at the conclusion of the 2007 examination,
such as downgrading CAMELS ratings or executing an informal enforcement
action.

We also believe that a June 2008 credit risk target examination provided another
opportunity to pursue earlier, more forceful supervisory action. The target
examination provided strong evidence that Barnes’ risk profile and financial
condition had significantly changed, and examiners repeated prior criticisms.
While FRB San Francisco subsequently performed a separate ratings assessment
and downgraded several CAMELS ratings, an enforcement action was not
executed until May 2009, nearly one year after the target examination was
initiated. Further, although not explicitly required by supervisory guidance,
examiners decided not to attend a full Board of Directors meeting following the
target examination or assessment. Given the history of repeated
recommendations, continued market deterioration, and additional growth of the
bank’s CLD loan portfolio, FRB San Francisco could have taken such actions as
(1) conducting a formal exit meeting with the Board of Directors, (2) considering
more aggressive ratings downgrades, or (3) executing an enforcement action.

While we believe that FRB San Francisco had opportunities for earlier and more
forceful supervisory actions, it was not possible for us to predict the effectiveness
or impact of any such actions. Therefore, we could not evaluate the degree to
which earlier or more forceful supervisory responses might have affected Barnes’
financial deterioration or the failure’s cost to the DIF.




Semiannual Report to Congress             25                              October 2010
Barnes’ failure offered valuable lessons learned because it illustrated (1) the need
for close regulatory scrutiny and a forceful supervisory response when financial
institutions increase credit risk exposure within a weakened or deteriorating
market segment; and (2) although not explicitly required by supervisory guidance,
examiner attendance at a Board of Directors meeting can be a prudent supervisory
practice when a target examination notes a significant change in the institution’s
financial condition and risk profile.

The Director of the Board’s Division of Banking Supervision and Regulation
agreed with our conclusion and concurred with the lessons learned.


Review of the Failure of Marco Community Bank

Marco Community Bank (Marco) was a de novo bank supervised by FRB
Atlanta, under delegated authority from the Board, and by the Florida Office of
Financial Regulation (State). The State closed Marco on February 19, 2010, and
named the FDIC as receiver. The FDIC IG estimated that Marco’s failure would
result in a $36.9 million loss to the DIF, or 29.1 percent of the bank’s
$126.9 million in total assets. While the loss did not exceed the materiality
threshold established in the Dodd-Frank Act, we conducted an in-depth review
after determining that Marco’s failure presented unusual circumstances because
(1) during its second year of operations, tier 1 capital dipped beneath the
minimum required by regulatory guidance, and (2) the bank relied heavily on its
holding company to augment the bank’s capital throughout Marco’s limited
history.

Marco failed because its Board of Directors and management did not provide
adequate oversight of the bank’s lending activities. Following its inception, the
bank operated with a weak internal control environment due, in part, to frequent
management turnover, vacancies in key positions, and inadequate staff expertise.
The bank grew more quickly than management anticipated in its business plan
and relied on capital injections from its holding company to sustain operations.
The growth resulted in Marco developing high concentrations in (1) the CLD
component of the bank’s CRE loan portfolio, and (2) home equity lines of credit.
Also, in 2006 and 2007, the bank executed management’s strategic decision to
supplement its declining loan production by purchasing a pool of short-term
acquisition and renovation loans on properties primarily located in two counties in
Florida. These loan pools created an additional concentration risk for Marco. As
the real estate market in Marco Island weakened, the bank’s asset quality
deteriorated significantly and resulted in large provision expenses that eliminated
earnings and depleted capital.

Our analysis of FRB Atlanta’s supervision of Marco revealed that FRB Atlanta
did not fully comply with the Board’s supervisory standards for de novo banks.
Specifically, FRB Atlanta did not comply with examination frequency guidelines


Semiannual Report to Congress             26                            October 2010
and put Marco on a standard examination cycle despite noting issues that should
have raised concerns about the bank’s ability to operate on a sound basis—a
consideration when determining if a de novo bank should be transitioned to a
standard examination frequency cycle.

We believe that FRB Atlanta should not have transitioned Marco to the standard
examination cycle after FRB Atlanta and the State had only conducted two full
scope examinations. In hindsight, we believe that many of the issues noted during
these first two examinations foreshadowed the bank’s future problems.
Nevertheless, it was not possible to determine the degree to which strict
adherence to the supervisory guidelines for de novo banks may have altered the
course of the bank’s financial decline or affected the failure’s cost to the DIF.

We believe that Marco’s failure pointed to valuable lessons learned that can be
applied when supervising de novo banks with similar characteristics. First,
Marco’s failure underscored that de novo banks require close supervision and that
examiners should only implement the standard examination cycle when—
consistent with regulatory guidance—the bank’s corporate governance, financial
condition, and internal controls warrant the transition. Second, this failure
highlighted the importance of examiners closely monitoring a de novo bank’s
performance when, as was the case with Marco, there are significant deviations
from the business plan submitted as part of the application to become a state
member bank.

The Director of the Board’s Division of Banking Supervision and Regulation
concurred with our conclusion and lessons learned.


ONGOING INSPECTION AND EVALUATION WORK

Failed Bank Reviews

With the enactment of the Dodd-Frank Act, the OIG is required to review failed
banks where the losses to the DIF are above the materiality threshold or are below
the threshold but exhibit unusual circumstances warranting an in-depth review.
Pursuant to the Dodd-Frank Act, a $200 million threshold applies for losses that
occur between January 1, 2010, and December 31, 2011. As discussed below, we
are currently conducting two failed bank reviews. These banks had total assets of
approximately $3.7 billion and total losses estimated at $222 million, or
approximately 6 percent of total assets.


Independent Bankers’ Bank

On December 18, 2009, Independent Bankers’ Bank (IBB), Springfield, Illinois,
was closed by the Illinois Department of Financial and Professional Regulation.


Semiannual Report to Congress            27                            October 2010
At closure, the FDIC reported that IBB had $585.5 million in total assets as of
September 30, 2009. In January 2010, the FDIC informed us that the cost of the
failure was estimated to be $20.8 million, which did not meet the materiality
threshold as defined under Section 38(k) of the FDI Act. However, as is
discussed in more detail in the next section (see page 29), under the Dodd-Frank
Act, the IG of each federal banking agency is required to review all losses to the
DIF that occurred after October 1, 2009, and determine if unusual circumstances
existed. We have determined that IBB’s business model presents unusual
circumstances related to payment systems risks and, therefore, have begun an in-
depth review. We expect to issue our report in the next reporting period.


Midwest Bank and Trust Company

On May 14, 2010, Midwest Bank and Trust Company (Midwest), Elmwood Park,
Illinois, was closed by the Illinois Department of Financial and Professional
Regulation. At the time of closure, Midwest had approximately $3.1 billion in
total assets. On June 8, 2010, the FDIC IG notified our office that the FDIC had
estimated a $200.7 million loss to the DIF, which exceeds the statutory threshold
requiring us to conduct a material loss review.


Analysis of Lessons Learned from OIG Bank Failure Reviews

We have begun a cross-cutting review of lessons learned from our cumulative
body of bank failure reviews. Our work is focused on identifying (1) emerging
themes related to the cause of state member bank failures and Federal Reserve
supervision of these institutions, and (2) potential recommendations for
improvements in bank supervisory policies and practices. We plan to complete
our analysis and issue a report during the next reporting period.




Semiannual Report to Congress            28                             October 2010
Information on Nonmaterial Losses to the Deposit
Insurance Fund, as Required by the Dodd-Frank Act
The Dodd-Frank Act requires the IG of the appropriate Federal banking agency to
report, on a semiannual basis, certain information on financial institutions that
incurred nonmaterial losses to the DIF and that failed during the respective six-
month period. 4 However, for this first report since the enactment of the Dodd-
Frank Act, the reporting period is October 1, 2009, through September 30, 2010.
As shown in the table on the next page, 12 failed state member banks had losses
to the DIF that did not meet the materiality threshold. Cumulatively, these
institutions had total assets of approximately $3.8 billion and losses estimated at
$626 million, or 16.6 percent of total assets.

Pursuant to the Dodd-Frank Act, the IG is required to determine (1) the grounds
identified by the State for appointing the FDIC as receiver, and (2) whether losses
to the DIF presented unusual circumstances that would warrant an in-depth
review. If no unusual circumstances are identified, the IG is required to provide
an explanation of its determination.

We reviewed each of the 12 state member bank failures to determine if the
resulting loss to the DIF exhibited unusual circumstances that would warrant an
in-depth review. We considered a loss to the DIF to present unusual
circumstances if the conditions associated with the bank’s deterioration, ultimate
closure, and supervision were not addressed in any of our prior bank failure
reports or involved potential fraudulent activity. To make this determination, we
analyzed key data from the five-year period preceding the bank’s closure. This
data generally comprised Federal Reserve Bank and State examination schedules;
Reports of Examination, including CAMELS ratings and financial data; informal
and formal enforcement actions and other supervisory activities, such as
visitations; and PCA determinations. As shown in the table on the next page, we
determined that losses to the DIF for two state member banks exhibited unusual
circumstances warranting an in-depth review. We did not find unusual
circumstances in the remaining institutions.




     4. In accordance with the Dodd-Frank Act, a loss to the DIF that occurs between January 1, 2010, and December 31,
2011, is material if it exceeds $200 million. The Dodd-Frank Act changed the long-standing material loss threshold of the
FDI Act, which had been defined as the greater of $25 million or 2 percent of the bank’s total assets.

Semiannual Report to Congress                                   29                                      October 2010
Nonmaterial State Member Bank Failures,
October 1, 2009, through September 30, 2010
                                                    Projected                 OIG Summary of
                                       Asset size     Loss        Closure     State’s Grounds
 State Member Bank      Location       (millions)   (millions)     Date       for Receivership          OIG Determination

Independent Bankers’    Springfield,    $ 585.5      $ 20.8      12/18/2009     Operating in an        Unusual circumstances
   Bank                     IL                                                unsafe and unsound       identified; report to be
                                                                                    manner              issued by 03/31/2011
                                                                                                            (see page 27)

Marco Community        Marco Island,    $ 126.9      $ 36.9      02/19/2010        Imminent            Unusual circumstances
  Bank                     FL                                                     insolvency              identified; report
                                                                                                       issued on 09/30/2010
                                                                                                            (see page 26)

Bank of Illinois        Normal, IL     $ 205.3       $ 53.7      03/05/2010    Capital impaired,             No unusual
                                                                              unsound condition,        circumstances noted
                                                                                operating in an
                                                                              unsafe and unsound
                                                                                    manner

Sun American Bank      Boca Raton,     $ 543.6       $103.0      03/05/2010        Imminent                  No unusual
                           FL                                                     insolvency            circumstances noted

Old Southern Bank      Orlando, FL     $ 351.0       $ 90.5      03/12/2010        Imminent                  No unusual
                                                                                  insolvency            circumstances noted

1st Pacific Bank        San Diego,     $ 327.3       $ 75.1      05/07/2010     No reasonable                No unusual
                           CA                                                    prospect for           circumstances noted
                                                                                rehabilitation

Metro Bank of Dade      Miami, FL      $ 442.3       $ 67.6      07/16/2010   Insolvency due to              No unusual
  County                                                                         losses from            circumstances noted
                                                                                  operations

Home Valley Bank          Cave         $ 251.8       $ 37.1      07/23/2010   Insolvency due to              No unusual
                       Junction, OR                                             excessive non-          circumstances noted
                                                                              performing assets

Sterling Bank           Lantana, FL    $ 407.9       $ 45.5      07/23/2010      Insolvent; no               No unusual
                                                                                  prospect for          circumstances noted
                                                                              replacement capital

Thunder Bank           Sylvan Grove,   $   32.6      $ 4.5       07/23/2010     Capital to total             No unusual
                            KS                                                 assets equal to or       circumstances noted
                                                                              less than 2 percent

Pacific State Bank     Stockton, CA    $ 312.1       $ 32.6      08/20/2010     No reasonable                No unusual
                                                                                 prospect for           circumstances noted
                                                                                rehabilitation

Horizon Bank            Bradenton,     $ 187.8       $ 58.9      09/10/2010        Imminent                  No unusual
                           FL                                                     insolvency            circumstances noted




Semiannual Report to Congress                           30                                          October 2010
Investigations
The Investigations program conducts criminal, civil, and administrative
investigations of the Board’s programs and operations. OIG investigations are
conducted in compliance with the CIGIE’s Quality Standards for Investigations.

In June 2010, the U.S. Attorney General granted statutory law enforcement
authority to the Board OIG, which vested our special agents with the authority to
carry firearms, make arrests without a warrant, seek and execute search and arrest
warrants, and seize evidence. Previously, OIG special agents relied on a blanket
special deputation arrangement with the U.S. Marshals Service for their law
enforcement authority. The Attorney General’s authorization is an indicator of the
important function our special agents play in the investigation of complex criminal
matters that may affect Board-related programs and operations. This authority
bolsters the OIG’s ability to engage in joint task force and other criminal
investigations involving matters such as bank fraud, mortgage fraud, money
laundering, and other financially-related crimes impacting federally regulated
financial institutions.


ONGOING INVESTIGATIVE ACTIVITIES

Our criminal investigative activities involve leading or participating in a number
of multi-agency investigations. OIG special agents conduct investigations of
alleged criminal or otherwise prohibited activities relating to the Board’s
programs and operations. During this reporting period, we opened six new
investigations and closed one investigation. Due to the sensitivity of these
investigations, we only report on activities that have resulted in criminal, civil, or
administrative action. The following are highlights of our significant
investigative activity over the last six months.


Board Employee Entered Guilty Plea for Stealing and
Distributing Board Cell Phones

As noted in our last semiannual report, in late 2007 the OIG initiated an
investigation into the alleged theft of government cell phones. The investigation
determined that at least 26 cell phones were missing and that the Board incurred
associated charges in excess of $215,000, primarily due to international calls to
Jamaica, Brazil, Costa Rica, and the United Kingdom. A Board employee was
indicted in October 2009 for selling at least 10 cell phones, some for as much as
$250 each. Other phones were allegedly traded for services, such as discounts for
hairstyling services. The employee was charged with theft of government
property, trafficking in unauthorized access devices, and tampering with witness
testimony.

During the current reporting period, the Board employee pleaded guilty to one
count of theft of government property. She is scheduled to be sentenced in


Semiannual Report to Congress                 31                            October 2010
December 2010 and faces up to one year in prison under federal sentencing
guidelines. According to the government’s evidence, the employee stole at least
seven cell phones and told recipients of the phones that the phones came with
unlimited calling plans. The recipients proceeded to incur approximately $60,000
in cell phone charges that were billed to the Board.


California Woman Sentenced to Eight Years in Prison for False Personation of
a Federal Reserve Official in an Advance Fee Scam

In June 2010, a California woman was sentenced to 96 months in federal prison
for participating in an advance fee scheme that collected approximately $3.8
million from victims who were falsely promised low-interest, multi-million dollar
loans from the “Federal Reserve Bank.” As part of the sentence, the subject was
ordered to pay approximately $3.8 million in restitution, which represented losses
to victims resulting from the fraudulent scheme. In addition, the government
seized appropriately $1 million from the subject’s bank accounts that will be used
to help repay the victims.

As we indicated in our last semiannual report, the OIG initiated its investigation
into this matter in late 2008. This investigation was conducted jointly with the
Federal Bureau of Investigation, U.S. Immigration and Customs Enforcement, the
U.S. Postal Inspection Service, and the Los Angeles Police Department.

The subject held herself out as an employee of the Federal Reserve Bank and
fraudulently promised 30-year business loans at a fixed rate of 2.3 percent to her
victims. The subject maintained that she was a loan consultant and that she could
secure the loans without any standard documentation because she worked directly
with the head underwriter of the Federal Reserve Bank. As part of the loan
scheme, the subject induced victims to make up-front cash payments, which were
generally about 5 percent of the loan amount. None of the victims received a loan
or saw the return of their advance payments.

In January 2010, the subject pleaded guilty to a criminal information charging
wire fraud, money laundering, false personation of an employee of a Federal
Reserve Bank, and causing an act to be done.


Individual Pleaded Guilty to Trafficking in Counterfeit Goods

During this reporting period, an individual pleaded guilty to one count of
trafficking in counterfeit goods and is awaiting sentencing. As was previously
reported, the OIG initiated its investigation based on a request for assistance from
the U.S. Postal Inspection Service concerning alleged money laundering and
structured deposits by two subjects. The investigation determined that, over a
one-year period, the subjects deposited approximately $1 million of Postal Money


Semiannual Report to Congress             32                             October 2010
Orders into bank accounts at various financial institutions, including several
Board regulated institutions. Information developed during the investigation
revealed that the subjects were aware of the Postal Money Order purchasing
requirements and patterned their purchases to avoid detection.

In December 2009, a federal grand jury indicted the subjects on charges of money
laundering and trafficking in counterfeit goods. The indictment charged that the
subjects knowingly conducted financial transactions affecting interstate and
foreign commerce with the structured purchase of 636 Postal Money Orders
valued at $579,865, which involved the proceeds from the unlawful sale of
counterfeit merchandise throughout the United States. During this investigation,
OIG special agents worked closely with Postal Inspectors analyzing financial
transactions in support of the potential money laundering violations.


OIG Participation in Nationwide Effort to Combat Financial Fraud

The OIG is continuing its participation in the nationwide effort by the Federal
Bureau of Investigation and the U.S. Attorney’s Office to investigate and
prosecute mortgage-related crimes. The President established the interagency
Financial Fraud Enforcement Task Force to wage an aggressive, coordinated, and
proactive effort to investigate and prosecute financial crimes. The task force
includes representatives from a broad range of federal agencies, regulatory
authorities, OIGs, and state and local law enforcement who, working together,
bring to bear a powerful array of criminal and civil enforcement resources. The
task force is working to improve efforts across the federal executive branch, as
well as with state and local partners, to investigate and prosecute significant
financial crimes, ensure just and effective punishment for those who perpetrate
financial crimes, combat discrimination in the lending and financial markets, and
recover proceeds for victims of financial crimes.


Subjects Pleaded Guilty in Mortgage Fraud Task Force Investigation

An investigation by OIG special agents assigned to the Maryland Mortgage Fraud
Task Force recently resulted in the arrest of three subjects involved in a mortgage
fraud scheme that netted more than $1.2 million from three federally regulated
financial institutions. This investigation was conducted in conjunction with the
President’s Financial Fraud Enforcement Task Force. The investigation disclosed
that between June and September 2007, the subjects submitted false mortgage
applications for three properties that included false certifications of occupancy
and inflated income. Each of the properties went into foreclosure or short sale,
resulting in a total loss to the banks of more than $850,000.




Semiannual Report to Congress            33                             October 2010
Two of the subjects arrested have since pleaded guilty to conspiracy to commit
wire fraud and are awaiting sentencing. Each faces a maximum sentence of up to
30 years in prison and a $1 million fine.

Summary Statistics on Investigations during the Reporting Period
                            Investigative Actions                    Number

 Investigative Caseload
    Investigations Open at End of Previous Reporting Period           36
    Investigations Opened during Reporting Period                      6
    Investigations Closed during Reporting Period                      1
    Total Investigations Open at End of Reporting Period              41
 Investigative Results for Reporting Period
    Referred to Prosecutor                                              7
    Joint Investigations                                               28
    Referred for Audit                                                  0
    Referred for Administrative Action                                  1
    Oral and/or Written Reprimands                                      0
    Terminations of Employment                                          0
    Arrests                                                             3
    Suspensions                                                         0
    Debarments                                                          0
    Indictments                                                         3
    Criminal Information                                                0
    Convictions                                                         4
    Monetary Recoveries                                                $0
    Civil Actions (Fines and Restitution)                              $0
    Criminal Fines (Fines and Restitution)                     $3,810,000




Semiannual Report to Congress                             34                October 2010
Hotline Operations

Consistent with the mission, goals, and objectives of the OIG, the Hotline system
serves as a means for individuals to report allegations of fraud, waste, abuse, and
mismanagement involving Board programs and operations. During this reporting
period, the Hotline received 586 complaints.

The OIG continued to receive a significant number of complaints concerning
fictitious instrument fraud and “phishing” scams. Many of these schemes are in
the form of advance fee, lottery, and Nigerian scams, and some invoke the Federal
Reserve name. These solicitations attempt to obtain the personal identifying
information or financial information of the recipient. While the content of these
types of schemes can differ, they can include a solicitation from an individual
purporting to represent the Board or a Reserve Bank, falsely claim that the
recipient has been awarded a large sum of money, and request information from
the recipient to further process an alleged transfer of funds. The Hotline advises
all individuals that neither the Board nor the Reserve Banks endorse these
solicitations or have involvement in them. As appropriate, these complaints may
be investigated by the OIG. Hotline staff is currently monitoring and analyzing
these types of complaints to detect patterns and trends.

A number of other Hotline complaints were from consumers wanting to file non-
criminal consumer complaints against financial institutions. We typically refer
these complaints to the Federal Reserve Consumer Help (FRCH) unit, a
centralized operation of the Federal Reserve System that assists consumers in
filing complaints involving financial institutions. As indicated in FRCH’s
website, if a complaint is against a financial institution that the Federal Reserve
supervises, it will be investigated by 1 of the 12 regional Federal Reserve Banks.
Other hotline complaints were from individuals seeking advice or information
regarding monetary policy and consumer protections. These inquiries were
referred to the appropriate Board offices and other federal or state agencies.

Summary Statistics on Hotline Activities during the Reporting Period
           Hotline Complaints                                     Number

 Complaints Pending from Previous Reporting Period                  133
 Complaints Received during Reporting Period                        586
 Total Complaints for Reporting Period                              719
 Complaints Resolved during Reporting Period                        677
 Complaints Pending                                                  42




Semiannual Report to Congress                        35                    October 2010
Legal Services
The Legal Services program serves as the independent legal counsel to the IG and
the OIG staff. The Legal Services staff provides comprehensive legal advice,
research, counseling, analysis, and representation in support of OIG audits,
investigations, inspections, evaluations, and other professional, management, and
administrative functions. This work provides the legal basis for the conclusions,
findings, and recommendations contained within OIG reports. Moreover, Legal
Services keeps the IG and the OIG staff aware of recent legal developments that
may affect the activities of the OIG and the Board.

In accordance with section 4(a)(2) of the IG Act, the Legal Services staff conducts
an independent review of newly enacted and proposed legislation and regulations
to determine their potential effect on the economy and efficiency of the Board’s
programs and operations. During this reporting period, Legal Services reviewed
22 legislative and 3 regulatory items.




Semiannual Report to Congress            36                            October 2010
Communications and Coordination
While the OIG’s primary mission is to enhance the economy, efficiency, and
effectiveness of Board programs and operations, we also coordinate externally
and work internally to achieve our goals and objectives. Externally, we regularly
coordinate with and provide information to Congress and congressional staff. We
are also active members of the broader IG professional community, and we
promote collaboration on shared concerns. Internally, we consistently strive to
enhance and maximize efficiency and transparency in our infrastructure and
day-to-day operations. Within the Board and the Federal Reserve System, we
continue to provide information about the OIG’s roles and responsibilities and
participate, in an advisory capacity, on various Board work groups. Highlights of
our activities follow.


Congressional Coordination and Testimony

The OIG has been communicating and coordinating with various congressional
committees on issues of mutual interest. During the reporting period, we
provided 15 responses to congressional members and staff.


Council of Inspectors General on Financial Oversight

Section 989E of the Dodd-Frank Act established the CIGFO, which comprises the
IGs of the Board, the Commodity Futures Trading Commission, the Department
of Housing and Urban Development, the Treasury, the FDIC, the Federal Housing
Finance Agency, the National Credit Union Administration, the Securities and
Exchange Commission, and the TARP. The CIGFO is required to meet at least
quarterly to facilitate the sharing of information among the IGs and to discuss the
ongoing work of each IG, with a focus on concerns that may apply to the broader
financial sector and ways to improve financial oversight. The first meeting of the
CIGFO was held in October 2010. In addition, the CIGFO is required to annually
issue a report that highlights the IGs’ concerns and recommendations, as well as
issues that may apply to the broader financial sector.


Council of the Inspectors General on Integrity and Efficiency

The IG serves as a member of the CIGIE. Collectively, the members of the
CIGIE help improve government programs and operations. The CIGIE provides a
forum to discuss government-wide issues and shared concerns. The IG also
serves as a member of the CIGIE Legislation Committee, which is the central
point of information regarding legislative initiatives and congressional activities
that may affect the community.




Semiannual Report to Congress           37                             October 2010
Financial Regulatory Coordination

To foster cooperation on issues of mutual interest, including issues related to the
current financial crisis, the IG meets regularly with the IGs from other federal
financial regulatory agencies: the FDIC, the Treasury, the National Credit Union
Administration, the Securities and Exchange Commission, the Farm Credit
Administration, the Commodity Futures Trading Commission, the Pension
Benefit Guarantee Corporation, the Export-Import Bank, and the Federal Housing
Finance Agency. We also coordinate with the Government Accountability Office.
In addition, the Assistant IG for Audits and Attestations and the Assistant IG for
Inspections and Evaluations meet with their financial regulatory agency OIG
counterparts to discuss various topics, including bank failure material loss review
best practices, annual plans, and ongoing projects.


Other Committee, Workgroup, and Program Participation

The IG continues to serve on various Board committees and work groups, such as
the Senior Management Council. In addition, OIG staff members participate in a
variety of Board working groups, including the Space Planning Executive Group,
the Leading and Managing People Working Group, the Information Technology
Advisory Group, the Core Response Group, the Management Advisory Group, the
Information Security Committee, the Information Technology Strategic
Committee, the Board Data Council, and the Continuity of Operations Working
Group. Externally, the OIG legal staff are members of the Council of Counsels to
the Inspector General. In addition, the Assistant IG for Audits and Attestations
serves as co-chair of the Information Technology Committee of the Federal Audit
Executive Council and works with audit staff throughout the IG community on
common information technology (IT) audit issues.


Troubled Asset Relief Program Oversight

Our office participates with other financial regulatory OIGs on the TARP IG
Council to facilitate effective cooperation among those entities whose oversight
responsibilities relate to or affect the TARP.


OIG Information Technology

During the reporting period, the OIG IT team continued to monitor and maintain
the OIG automated information system’s FISMA compliance. Efforts included
performing regular contingency tests of the OIG IT environment and ensuring that
the OIG’s staff, contractors, and interns completed their annual security
awareness training. The team worked to ensure that OIG employees have reliable
and uninterrupted technological services that enable them to operate effectively


Semiannual Report to Congress           38                             October 2010
and explored new technology to enhance the IT infrastructure. The IT team
manages the OIG Microsoft Active Directory, network, and necessary
applications and is working to implement a new investigative application to
enhance Investigations’ information management. Consistent with FISMA
requirements, a security review of the OIG’s IT infrastructure will be conducted
during the next reporting period.


CIGIE Award

On October 19, 2010, Mr. Laurence A. Froehlich, former Assistant Inspector
General for Legal Services, was posthumously awarded the CIGIE June Gibbs
Brown Career Achievement Award. Mr. Froehlich was a champion of the IG
community who dedicated himself to the furtherance of the community’s mission,
values, and goals. He served the federal government with distinction for over 33
years, all of which were spent working for OIGs. Mr. Froehlich’s contributions to
the IG community were extensive, and their impact immeasurable. His dedication
to public service stands as an exemplar to the IG community.




Semiannual Report to Congress           39                            October 2010
Appendixes
Appendix 1
Audit, Inspection, and Evaluation Reports Issued with Questioned Costs
during the Reporting Perioda
                                       Reports                                              Number         Dollar Value

 For which no management decision had been made by the commencement of the                      0                 $0
    reporting period

 That were issued during the reporting period                                                   0                 $0

 For which a management decision was made during the reporting period                           0                 $0

  (i)    dollar value of recommendations that were agreed to by management                      0                 $0

  (ii)   dollar value of recommendations that were not agreed to by management                  0                 $0

 For which no management decision had been made by the end of the reporting period              0                 $0

 For which no management decision was made within six months of issuance                        0                $0

  a. Because the Board is primarily a regulatory and policymaking agency, our recommendations typically focus on
program effectiveness and efficiency, as well as strengthening internal controls. As such, the monetary benefit associated
with their implementation is often not readily quantifiable.




_______________________________________________________________________________
Semiannual Report to Congress          43                           October 2010
Appendix 2
Audit, Inspection, and Evaluation Reports Issued with Recommendations that
Funds Be Put to Better Use during the Reporting Perioda
                                       Reports                                              Number         Dollar Value

 For which no management decision had been made by the commencement of the                      0                 $0
    reporting period

 That were issued during the reporting period                                                   0                 $0

 For which a management decision was made during the reporting period                           0                 $0

  (i)    dollar value of recommendations that were agreed to by management                      0                 $0

  (ii)   dollar value of recommendations that were not agreed to by management                  0                 $0

 For which no management decision had been made by the end of the reporting period              0                 $0

 For which no management decision was made within six months of issuance                        0                $0

  a. Because the Board is primarily a regulatory and policymaking agency, our recommendations typically focus on
program effectiveness and efficiency, as well as strengthening internal controls. As such, the monetary benefit associated
with their implementation is often not readily quantifiable.




_______________________________________________________________________________
Semiannual Report to Congress          44                           October 2010
Appendix 3
OIG Reports with Recommendations that Were Open during
the Reporting Perioda
                                                                             Recommendations               Status of Recommendations

                                                                                                            Follow-up
                                                           Issue                  Mgmt.       Mgmt.         Completion
                       Report Title                        Date        No.        Agrees     Disagrees        Date         Closed Open

    Evaluation of Service Credit Computations              08/05         3            3           0            03/07           1     2

    Security Control Review of the Central Document        10/06        16          16            0            09/09          14     2
      and Text Repository System (Non-public Report)

    Audit of the Board’s Payroll Process                   12/06         7            7           0            03/10           3     4

    Security Control Review of the Internet Electronic     02/07        13          13            0            09/09          12     1
      Submission System (Non-public Report)

    Audit of the Board’s Compliance with Overtime          03/07         2           2            0            03/08           1     1
      Requirements of the Fair Labor Standards Act

    Security Control Review of the Federal Reserve         01/08         7           7            0            09/09           6     1
      Integrated Records Management Architecture
      (Non-public Report)

    Review of Selected Common Information Security         03/08         6           6            0              –             –     6
      Controls (Non-public Report)

    Security Control Review of the FISMA Assets            09/08        11          11            0              –             –    11
      Maintained by FRB Boston (Non-public Report)

    Evaluation of Data Flows for Board Employee Data       09/08         2           2            0              –             –     2
      Received by OEB and its Contractors (Non-public
      Report)

    Audit of the Board’s Information Security Program      09/08         2           2            0            11/09           1     1

    Control Review of the Board’s Currency                 09/08         6           6            0            03/10           5     1
      Expenditures and Assessments

    Audit of Blackberry and Cell Phone Internal Controls   03/09         3           3            0              –             –     3

    Inspection of the Board’s Law Enforcement Unit         03/09         2           2            0              –             –     2
      (Non-public Report)

    Security Control Review of the Audit Logging           03/09         4           4            0              –             –     4
      Provided by the Information Technology General
      Support System (Non-public Report)

    Material Loss Review of First Georgia Community        06/09         1           1            0              –             –     1
     Bank

    Material Loss Review of County Bank                    09/09         1           1            0              –             –     1

    Audit of the Board’s Processing of Applications for    09/09         2           2            0              –             –     2
      the Capital Purchase Program under the Troubled
      Asset Relief Program

    Audit of the Board’s Information Security Program      11/09         4           4            0              –             –     4
     



    a. A recommendation is closed if (1) the corrective action has been taken; (2) the recommendation is no longer applicable; or (3) the
appropriate oversight committee or administrator has determined, after reviewing the position of the OIG and division management, that
no further action by the Board is warranted. A recommendation is open if (1) division management agrees with the recommendation and
is in the process of taking corrective action, or (2) division management disagrees with the recommendation and we have referred or are
referring it to the appropriate oversight committee or administrator for a final decision.




Semiannual Report to Congress                                 45                                         October 2010
Appendix 3—continued
OIG Reports with Recommendations that Were Open during
the Reporting Period
                                                                   Recommendations           Status of Recommendations

                                                                                             Follow-up
                                                     Issue             Mgmt.     Mgmt.       Completion
                   Report Title                      Date    No.       Agrees   Disagrees      Date        Closed Open

 Material Loss Review of Community Bank of West      01/10    1           1          0            –           –    1
  Georgia

 Material Loss Review of CapitalSouth Bank           03/10    1           1          0            –           –    1

 Security Control Review of the Lotus Notes and      06/10   10          10          0            –           –   10
   Lotus Domino Infrastructure (Non-public Report)




Semiannual Report to Congress                           46                                  October 2010
Appendix 4
Audit, Inspection, and Evaluation Reports Issued during the Reporting Period
                                           Title                             Type of Report

Security Control Review of the Lotus Notes and Lotus Domino Infrastructure       Audit

Material Loss Review of Warren Bank                                            Evaluation

Material Loss Review of Irwin Union Bank and Trust                             Evaluation

Material Loss Review of Bank of Elmwood                                        Evaluation

Material Loss Review of San Joaquin Bank                                       Evaluation

Material Loss Review of Orion Bank                                             Evaluation

Material Loss Review of SolutionsBank                                          Evaluation

Material Loss Review of Barnes Banking Company                                 Evaluation

Review of the Failure of Marco Community Bank                                  Evaluation




Total Number of Audit Reports: 1
Total Number of Inspection and Evaluation Reports: 8


Full copies of these reports are available on our website at
http://www.federalreserve.gov/oig/default.htm




Semiannual Report to Congress                              47                 October 2010
Appendix 5
OIG Peer Reviews

Government auditing and investigative standards require that our audit and
investigative units each be reviewed by a peer OIG organization every three
years. Section 989C of the Dodd-Frank Act amended the IG Act to require that
OIGs provide in their semiannual reports to Congress specified information
regarding (1) peer reviews of their respective organizations and (2) peer reviews
they have conducted of other OIGs. The following information is provided to
address the Dodd-Frank Act requirements.

        No peer reviews of the OIG were conducted during this reporting period.

        The last peer review of the OIG’s Audits and Attestations program was
         completed in September 2008 by the U.S. Government Printing Office
         OIG. No recommendations from this or any prior peer reviews are
         pending.

        The last peer review of the OIG’s Investigations program was completed
         in March 2008 by the U.S. Government Printing Office OIG. No
         recommendations from this or any prior peer reviews are pending.

        The Board OIG did not conduct any peer reviews of other OIGs during
         this reporting period.

Copies of our peer review reports are available on our website at
http://www.federalreserve.gov/oig/peer_review_reports.htm.




Semiannual Report to Congress            48                            October 2010
Appendix 6
Cross-References to the Inspector General Act, as amended
Indexed below are the reporting requirements prescribed by the Inspector
General Act of 1978, as amended, during the reporting period.
      Section                                             Source                                   Page(s)

4(a)(2)           Review of legislation and regulations                                              36

5(a)(1)           Significant problems, abuses, and deficiencies                                    None

5(a)(2)           Recommendations with respect to significant problems                              None

5(a)(3)           Significant recommendations described in previous semiannual reports on which     None
                  corrective action has not been completed

5(a)(4)           Matters referred to prosecutorial authorities                                      34

5(a)(5);6(b)(2)   Summary of instances where information was refused                                None

5(a)(6)           List of audit, inspection, and evaluation reports                                  47

5(a)(7)           Summary of particularly significant reports                                       None

5(a)(8)           Statistical table of questioned costs                                              43

5(a)(9)           Statistical table of recommendations that funds be put to better use               44

5(a)(10)          Summary of audit, inspection, and evaluation reports issued before the            None
                  commencement of the reporting period for which no management decision has
                  been made

5(a)(11)          Significant revised management decisions made during the reporting period         None

5(a)(12)          Significant management decisions with which the Inspector General is in           None
                  disagreement

5(a)(14), (15),   Peer Review Summary                                                                48
 and (16)




Semiannual Report to Congress                               49                                    October 2010
Table of Acronyms and Abbreviations
 ADC                 Acquisition, Development, and Construction

 ALLL                Allowance for Loan and Lease Losses

 Barnes              Barnes Banking Company

 Board               Board of Governors of the Federal Reserve System

 Bureau              Bureau of Consumer Financial Protection

 CEO                 Chief Executive Officer

 CIGFO               Council of Inspectors General on Financial Oversight

 CIGIE               Council of the Inspectors General on Integrity and Efficiency

 CLD                 Construction, Land, and Land Development

 CRE                 Commercial Real Estate

 DIF                 Deposit Insurance Fund

 Dodd-Frank Act      Dodd-Frank Wall Street Reform and Consumer Protection Act

 Elmwood             Bank of Elmwood

 FDI Act             Federal Deposit Insurance Act

 FDIC                Federal Deposit Insurance Corporation

 FFIEC               Federal Financial Institutions Examination Council

 FISMA               Federal Information Security Management Act of 2002

 FRB Atlanta         Federal Reserve Bank of Atlanta

 FRB Chicago         Federal Reserve Bank of Chicago

 FRB Kansas City     Federal Reserve Bank of Kansas City

 FRB San Francisco   Federal Reserve Bank of San Francisco

 FRCH                Federal Reserve Consumer Help

 FSOC                Financial Stability Oversight Council

 IBB                 Independent Bankers’ Bank

 IESub               Internet Electronic Submission

 IG                  Inspector General




Semiannual Report to Congress                  51                                October 2010
Table of Acronyms and Abbreviations
 IG Act              Inspector General Act of 1978, as amended

 IT                  Information Technology

 IUBT                Irwin Union Bank and Trust

 Marco               Marco Community Bank

 Midwest             Midwest Bank and Trust Company

 NRAS                National Remote Access Services

 OIG                 Office of Inspector General

 Orion               Orion Bank

 PCA                 Prompt Corrective Action

 PubWeb              Public Website

 San Joaquin         San Joaquin Bank

 Solutions           SolutionsBank

 TARP                Troubled Asset Relief Program

 Treasury            U.S. Department of the Treasury




Semiannual Report to Congress                   52               October 2010
           Inspector General Hotline
                1-202-452-6400
                1-800-827-3340

   Report: Fraud, Waste, or Mismanagement
        Caller may remain anonymous

             You may also write to:
           Office of Inspector General
                    HOTLINE
Board of Governors of the Federal Reserve System
    20th Street and Constitution Avenue, NW
                      MS-300
             Washington, DC 20551

         or visit our hotline web page at:
http://www.federalreserve.gov/oig/oig_hotline.htm

				
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